Monday, August 21, 2017

Bad faith claim rejected in MeadWestvaco-Rock-Tenn merger suit

The Delaware Chancery Court dismissed a bad faith claim brought by shareholders of MeadWestvaco Corporation against the company’s board of directors over the alleged undervaluation of non-core assets in a merger of equals between MeadWestvaco and Rock-Tenn Company. The court likewise dismissed a related aiding and abetting claim against Rock-Tenn. MeadWestvaco’s shareholders had theorized that MeadWestvaco’s board acted hastily when an activist investor appeared, but the court ultimately focused on bad faith rather than the more recent Corwin cleansing vote option or on Revlon enhanced scrutiny or entire fairness (In re MeadWestvaco Corporation Stockholders Litigation, August 17, 2017, Bouchard, A.).

Flying blind. The MeadWestvaco shareholders’ complaint asserted that the company’s board was “flying blind” in order to rush a deal to mollify an activist shareholder (Starboard Value LP) whom it was feared may bring a proxy contest. The shareholders claimed that in its haste to procure a deal, MeadWestvaco’s board disregarded their fiduciary duties and allowed what the shareholders characterized as a low-ball valuation of MeadWestvaco’s four non-core assets. All told, the shareholders claimed they had been shortchanged by $3 billion in a deal that should have been worth $12 billion instead of the agreed $9 billion.

MeadWestvaco and Rock-Tenn each have core packaging businesses, while MeadWestvaco also has several non-core assets or businesses in diverse fields: specialty chemicals, a Brazilian subsidiary, and real estate holdings in the U.S. MeadWestvaco also has a pension surplus. Starboard made several proposals to extract greater value from MeadWestvaco, including cost cutting measures, a stock repurchase, sale of the company, or sale of the specialty chemicals business (Starboard later suggested a spin-off of the specialty chemicals unit). MeadWestvaco and Rock-Tenn engaged in merger negotiations from time to time, but MeadWestvaco spurned Rock-Tenn twice before they finally reach agreement.

The MeadWestvaco-Rock-Tenn deal involved a stock-for-stock merger of equals that paid a premium to MeadWestvaco’s shareholders. Despite deal protections, a lack of other suitors, the board’s “probing questions” to MeadWestvaco’s CEO, and the presence of eight outside directors on a board of nine that approved the merger, the shareholders still pursued their twin claims of bad faith and aiding and abetting a breach of fiduciary duty, both of which the court has now dismissed.

Bad faith claim falls short. Chancellor Bouchard quickly dismissed the notion that entire fairness would apply ab initio, while also dispelling the need for Revlon’s enhanced scrutiny. Instead, the focus was on whether the complaint alleged that a majority of MeadWestvaco’s board was not disinterested and independent (this was not truly in dispute) or whether the board acted in bad faith (this was in dispute). The defendant companies replied that either the complaint failed to plead bad faith or that Corwin cleansed the deal. Given the focus on bad faith, the chancellor never had occasion to discuss Corwin.

Chancellor Bouchard explained that bad faith claims in Delaware often face many hurdles. Chief among them are the alternative theories of bad faith: (1) extreme facts showing that otherwise disinterested directors intentionally disregarded their duties; or (2) a decision that is so outlandish that it could only be explained as having resulted from bad faith.

According to the court, the shareholder’s theory did not hold up in the face of months-long consideration of the deal by MeadWestvaco’s board, at least six board meetings to discuss the deal, and the receipt of multiple valuations secured from prominent financial advisers. MeadWestvaco had even rebuffed prior merger entreaties by Rock-Tenn and only agreed to the deal that eventually closed because of that deal’s increased premium. Moreover, eight of the nine MeadWestvaco directors who approved the merger were disinterested and independent, a fact not seriously challenged by the shareholders.

The decision by MeadWestvaco’s board to approve the deal price ($9 billion) also did not reflect bad faith. The merger agreement had reflected a 9.1 percent premium in a merger of equals (MeadWestvaco got 50.1 percent of the combined entity, but contributed under 50 percent of the new entity’s revenues, net income, and EBITDA) and without any sale of control. Three allegedly unconflicted financial advisers said the deal was fair, the merger agreement contained reasonable deal protections, and two major proxy advisory firms recommended that MeadWestvaco’s shareholders approve the merger (the approval vote reached 98 percent on voting by 83 percent of outstanding shares).

Aiding and abetting claim fails. MeadWestvaco’s shareholders also claimed that Rock-Tenn aided and abetted a breach of fiduciary duty by MeadWestvaco’s board. Although Chancellor Bouchard said this claim would fail due to the lack of a predicate breach, he nevertheless discussed the scienter component of one of the elements of an aiding and abetting claim, which requires the defendant’s knowing participation in the breach. The court described this aspect of the shareholders’ claim as a “stringent” requirement.

Accordingly, the court found no non-conclusory allegations that Rock-Tenn knew of fiduciary duty breaches by MeadWestvaco’s board. Instead, the court said the complaint itself suggested that the MeadWestvaco-Rock-Tenn merger was the product of “genuine arm’s-length bargaining.”